How Blockchain Could Have Prevented the 2008 Financial Crisis
Last month, I went to India. On the way back from the airport, the driver saw me working on my laptop and spotted my Blockchain at Berkeley sticker. He smiled. I sort of panicked and put on a fake grim identity. Upon alighting from the car, he asked me a question softly. I hurriedly put my hand into my purse to make the payment but was stopped— I realized that what the cabbie had actually asked was, “I want to invest in an ICO thing, which one do you suggest?” He added that he is a student who works as a cabbie at night to augment his earning, and if I could help him, he would make some extra money for his family.
Blockchain and cryptocurrencies have, for quite a long time, been buzzwords. This December, the company Croe, which previously developed women’s fitness clothing, re-branded itself as “The Crypto Company”. The famous Long Island Iced Tea Corporation renamed itself “Long Blockchain” (totally normal, right?). The company’s shares promptly rose about 200 percent.
It seems like companies — start-ups or multinationals — are eagerly attaching the word blockchain onto any social media post/press release they can, and they successfully end up attracting thousands more consumers because of the usage of such a “magical” word without knowing the crux of what a blockchain actually is.
But there is far more power contained in this mere term. It is speculated that blockchain alone could have prevented the financial crisis.
Blockchain’s Power on the 2008 Financial Crisis
Blockchain could allow for the confirmation and ownership transfer of basically anything — from renewable energy certificates to shipment verification. Having worked at a hedge fund, I clearly see how distributed ledger technologies can provide regulators with visibility of trading portfolios of swap counter-parties — something that became the root cause of the crisis. It would give new smart securities and derivatives the ability to value themselves in real time, report to data repositories, and calculate margin payments dynamically even when a counter-party defaults.
In 2008, Lehman Brothers filed bankruptcy. Lehman’s bankruptcy filing was the largest in history — it had $639 billion USD in assets and $619 billion USD in debt. The availability of the transaction record of Lehman Brothers would have allowed the regulators to use smart data mining and machine learning tools to identify anomalies in trading activities and divergence in counter-party exposure, widening credit spreads and disruptions in short term funding activity. The capital markets would have much earlier identified Lehman’s falling creditworthiness, re-priced Lehman CDS risk, and hence acted as natural brake on Lehman expanding its business. It would have provided positive incentive to other entities such as Bear Sterns, Merrill Lynch and Citibank to strengthen their balance-sheet through fall in their CDS, hence cost of borrowing, i.e. increase in profitability and higher shareholder wealth creation.
It is estimated that almost a trillion dollars of assets are immobilised across the world due to bankruptcy proceedings. Even Lehman, the biggest and most tracked bankruptcy in the world, is yet to be fully resolved 10 years after the crisis. A trillion dollars of productive assets can take almost one-third of world’s poor out of poverty. With blockchain at its full potential, bankruptcy would become history since corrective action could be taken before a firm gets bankrupt.
IBM Global Financing reduced time spent resolving financial disputes by 75% using blockchain technology. With blockchain, participants in the transaction:
- Share a single platform with permissioned and secure access
- Receive a full view of the process and history
- Provide ability to see all steps in the process
- Give ability to pinpoint the moment when a delay or error occurs
- Allow quick-fix of problems without filing a dispute (due to increased transparency)
- Achieve on-boarding with minimal disruption (due to easy access)
It’s no wonder, then, that the financial sector is at the forefront in adoption of blockchain technology. The chart below indicates the percentage of DLT service providers with customers in different induestries; at the top of the list, it is clear that banks are the main customers of these services.
Furthermore, the table below describes the extent of blockchain initiatives of various banks, as per Business Insider.
In fact, Bank Santander estimates that DLT could save up to $20 billion a year for the banks.
Banks as they currently exist, would cease to exist in less than two decades. Banks are creatures of trust. We trust banks, hence deposit our hard-earned money with them. In turn, banks take our deposit and give as loan to those to whom the bank can trust. If this “trust” can be dehumanised into a “distributed ledger” which is inherently trustworthy, then banks would cease to exist since the core function would increasingly be taken over by peer-to-peer networks. The financing would change from being predominantly asset-backed to becoming cash-flow based. It would not matter whether the firm has assets, as long as it has robust cash-flow it would have access to capital markets, as shown in the figure below.
Future of Banking
The banks would increasing move away from transaction-based models (aka investment banking) to annuity-based models (wealth management). JP Morgan and Oliver Wayman have identified four Waves of blockchain deployment:
Distributed ledger technology is not only credible, but it also creates opportunities for asset managers and has the potential to revolutionise the way we do business. Just as predicting the impact the internet would have on us was an extremely hard task, trying to map out exactly how blockchain will affect us is nearly impossible. However, recognising the impact that FinTech innovation continues to have on the industry is vital to be able to unlock economic advantage in an increasingly digital world.
And finally for the uninitiated, unblocking the chain:
For your reading list: an excellent exposition on global blockchain benchmarking study is the Global Blockchain Benchmarking Study (2017) by Dr Garrick Hileman & Michel Rauchs, Judge Business School, University of Cambridge.
